To,
Honorable Prime Minister of
India,
Shree Narendra Modi
Sub : RBI have got Detached from reality
Dear Sir,
There are two most powerful persons
in India whose decision can affect the lives of common man in most profound way
– one is you as a PM and second is Raghuram Rajan. Unfortunately your every step is analyzed up
to depth and Raghuram Rajan is given a free pass for all his decisions.
Biggest change in policy that
India witnessed post 1991 economic reform was in March 2014 when we shifted to
CPI from WPI. Effectively you have been
given India whose currency got changed. A
Central Bank whose only mandate is
inflation, when changes its inflation measures dramatically virtually means it
changes its currency and surprisingly there is no debate on such a massive
policy shift and its pros and cons.
As I have a passion for economic
studies, and after years of observation of world economics and central banking,
I want to present in this letter how this change in policy of RBI can become
single biggest mistake that India can commit at this stage of India’s
development and present state of World economics.
WPI vs CPI
First looking at diverged
indication of WPI and CPI we need to conclude as an Indian, which inflation
measure reflects reality as both can’t be true with the gap of 7-10% as this
difference is equivalent to Greece and Germany to the Bond markets.
It’s true that
WPI is not perfect as it should have housing and services data embedded into
it. But still WPI have been the
impeccable predictor of state of India’s economy which can be seen in the chart
below.
Above long-term
chart clearly shows that WPI has clearly predicted some of the most important
events of India such as rise in inflation after dissolution of Bretten-Woods
agreement that finally led to JP movement and emergency, 1989-91 higher inflation that led to
liberalization or Asian Financial crisis and resultant inflation that made
Vajpayeejee’s task so difficult that finally just at the beginning of change
people lost faith in him. And same chart
shows- barring emergency, there has never been a time in post independence
India when our inflation have been negative and that too for so long as it is
now. And its implications are visible on
ground.
When there was a
wave in favor of UPA in 2008 , with inflation totally in control and India’s
growth near to 8 % under UPA1, and on the other hand your Gujarat Government
had a massive crack down on farm theft and
even kishan sangh was against you , results of your work was still not totally
visible on ground; yet as per me in
the most important election of India ever, Gujaratis voted for you in
2008. Just 18 months ago there was not a
single seat that was won for margin less than 125000 in Loksabha elections by
BJP. But in 18 months BJP lost panchayat
election or Hardik Patel’s irrational demand got resonated among the Gujaratis
is worth noting. It’s a protest by most
matured electorate in India as they feel something is wrong. As most other events are predicted through
WPI chart so is this. WPI is negative. It’s a vote against Raghuram Rajan’s
understanding of real India. People are
in real distress at lower bottom of the pyramid and for many reasons.
1.)
52 % of India’s population is dependent on
Agriculture. And CPI has 46 % weight age
for food on which RBI has no control.
Irony of the fact is if there is a draught, 52 % of the people’s
employment will be adversely affected. Biggest source of farmer suicide is debt
and RBI which should have come to rescue of these rural residents will increase
interest rates to burden these bottom of the pyramid people to see the savers
who are among top bracket gets more interest rate. Politician are questioned on every account
for farmer suicide but no one surprisingly asks anything to RBI governor how he
explains this paradox. With this policy
RBI is now the biggest threat to rural India as when they will be in distressed
instead of decreasing interest rates it will increase rates due to skewed
inflation measure. Using CPI to increase
interest rates during draught is akin to closing Bhakhara Nangal dam doors for
floods in Surat.
2.)
Raghuram Rajan himself uses a word ‘Quality of
deficit’ every time when he cuts interest rate, but has never followed what he
says. For a country like India where inflation
on large extent depends on currency movements, most important parameter for RBI
governor to watch for is the kind of deficit.
During UPA 2, subsidies were disbursed through various schemes directly
to rural areas which were causing immediate consumption with no asset or
infrastructure building- a perfect recipe for future inflation. But under your new NDA government precisely
opposite thing is happening. Money is
getting diverted to productive assets.
Just through DBT according to one estimate Rs. 15,000 crore has been
saved from leakages but though leakages this is financial tightening which
naturally results in rationally decreased consumption and hence structural decrease
in long term inflation. For left of the
center government it is so easy to give Loan waiver of Rs. 40,000 crore to
farmers but for right of the center government it is so difficult to spend Rs.
40,000 crore for housing for all. So
right of the center government’s decisions takes time to reach to masses as it
requires executions unlike subsidy disbursement. This delay should be compensated by lower
interest rates for smaller fiscal spending and future supply creations. Raghuram addresses this with his own acronym
of ‘Quality of deficit” but fails to act on it as should UPA 3 would have been in power his
interest rates be even higher? This
double whammy of prohibiting leakages and subsidies, and higher interest rates
is creating huge tightening in financial conditions in rural areas.
3.) Various
estimates suggest India’s 30-40% economy is unaccounted which is unique to
India as no other major country faces this issue at this scale. Add to this the fact that India’s lower
bottom of the pyramid are all in unorganized sectors and are affected most with
this black economy. With various steps
taken by governments from center to state and more by new NDA government there
is a massive crack down on black economy.
Every state has increased circle rates of land and market rates have
decreased dramatically in past two years.
This has resulted in crack down on black economy as biggest source of
hiding money is shrinking. This massive
reduction of black economy is good for the nation but has maximum implications
on lower bottom of the pyramid in short run and RBI has taken no note of
it. In foreign emulated policies it has
lost India’s ground reality again and is not able to compensate reduction in
black economy with channelized economy. Through financial inclusion and Mudra bank
initiatives government has done everything to solve this but if government has
built financial canals to reach to remotest people, Raghuram is sitting on Dam
door and is not allowing water to flow in optimized proportion.
4.) If
1998 was an Asian Financial Crisis, 2000 was Dot Com Bubble, 2008 was housing Bubble
for India 2012 was a Discom crisis. How west would have solved Discom crisis?
Central bank would have purchased floating bonds of discoms by quantitative
easing and there would not have been any NPA nor any distress in discom and UDAY would have
got fast forwarded by 4 years. Its true
India should not follow that extreme path but pragmatism suggests that when
there are Rs. 3,00,000 crore of debt in disarray lower interest rates are the only
panacea. 22 crore people in india don’t
have power, another 22 crore people don’t have power for more than 2 hours, and
instead of addressing Discom problem we are aggravating it by keeping interest
rates insanely high due to our disconnect from real economy which is choking
credit to every other segment of economy.
1.25 crore people in India are
entering workforce every year, meaning we are adding Australia to our workforce
every year. In order to create
employment for these, India needs massive infrastructure investments and all
the initiatives that government is rightly taking. But life blood of all these initiative is
invariably credit which RBI is deliberately inhibiting. RBI should be given
dual mandate of not just right kind of inflation targeting but also Employment
like USA’s Federal Reserve as Raghuram Rajan neither speaks of employment nor
do he take it into accounts in his policies. India’s youth can’t wait for long
and if RBI ‘s missteps results in failure of government policies, there can be
dozens of Hardiks emerging in country as people have immense hope in new government and when they
protest they don’t need a rational reason but just unemployment.
·
Raghuram Rajan says that WPI is international
inflation and CPI is domestic one. This
is most ill-informed statement by RBI governor.
CPI is not domestic driven inflation but its domestically spent
inflation. Meaning agreeably its spent
in Indian Rupee and hence its spend don’t go out of country but to say its
domestic inflation is absolutely wrong.
CPI has 46% food items whose rates are on large scale decided by global
commodity prices. Also it has energy in
it again dependent on global commodity prices.
So if he thinks CPI is solely controlled domestically his whole
understanding is wrong. Also because
it is domestically spent inflation and India’s wages are at bottom on global
scale we have far more resilience to tolerate its higher read and is desirable
at times, if other aspects such as stable fiscal and current accounts are in
place.
·
WPI is derived more from market driven data and
CPI is more a survey based data. Also
its worth noting that CPI‘s major weight age is through rural CPI which is
surveyed by 1100 odd post offices in villages who have no experience or dedication
of doing the survey. In a country as diverse
as India, where less frequent and more professional election poll surveys vary
so much, how can we rely on post office collected data on monthly basis on
which we predicate such a huge policy decisions. This is shear adaptation of OECD methodology
with no consideration of diversity and reality of Indian conditions. Also CPI don’t have credible history as it
was initiated in 2011.
·
Let us for a while assume that CPI is a right
measure. But Raghuram Rajan has other predetermined
conditions - repo rate should be CPI+1.5-2%. And this insanity don’t stop here
as India’s CPI inflation is averaging around 4.5-5 % from past one year, and by
that measure rate should be 6 % but no, he will takes base affect into
consideration and he will predict what will be the inflation in coming January,
though all his past inflaton predictions have been proved wrong on both sides,
and whether he is right or not his assumption will super cede all data and
hence rate will be kept at 6.75% !!!.
Even though market driven rate transmission system is able to pass just
75-100 bps of his 125 bps so be it because it’s the fault of market and banks
but not his. Affectively in spite of
once in decade’s event of collapse of commodities of this unprecedented manner,
India’s rates have got decreased by just 75-100bps. There is no doubt he is man of integrity but
India has always suffered because of people of integrity but with wrong
economic ideology and he is one among them again.
·
Former Governor Subbarao did excellent job during financial crisis
when he reduced interest rates from 9% to 4.75% in a matter of 7 months. This made India go unscathed in a
generational financial crisis in 2008-09.
But Raghuram Rajan takes this the other way. He thinks that inflation and subsequent
financial crisis that India faced was all because of this fall in interest
rates. This again is his incorrect understanding about India’s economy. India’s 2013 crisis and all previous crises
have just two roots- external or government’s socialist spending. Crude bounced from $33 to $ 120 in a matter
of 3 years but government failed to pass these and subsidized it with a bill of
Rs. 50,000 crore per annum? Does he think crude will again bounce to $120 so
quickly and if it does do he think present government will subsidize it? Does
he think government will go for socialist spending spree to increase its
deficit to 6%? Do he think that present governments massive work for Make in India
will go in vain and India’s current account will again rise to 6% of GDP?. As in 2013 and before, always India’s
inflation is a function of INR which again is a function of Government’s Economic
Ideology. For Federal Reserve, ECB and
PBOC their demand is world demand and hence their central bank has a large
control on their inflation. India’s
demand in present state has very little influence on world demand and hence India’s
entire inflation problems are related to government and its policies that affect
currency movement. RBI can do crisis
management during higher inflation or during deflation or during INR volatility
but ultimate control always lies with government unlike western central
banks. So RBI is trying to control
things that are not caused by it. RBI has
been the most pragmatic organization in worst of India’s financial crisis until
March 2014. This is for the first time
RBI is trying to influence the things that are all because of government and in
the process aggravating it. Present higher
CPI is because of higher pulses and why are pulses higher? In 2004 UPA disbanded river integration
project and hence the future supply and resorted to subsidies and unproductive
spend. Present government tries to
reverse this but RBI is inviting future inflation by keeping interest rate high
and stopping infrastructure spending in various sectors –irrigation included. Again hence it’s a question of ‘Quality of
Deficit’ where again he is failing on his own words.
·
Let us compare where India stands with respect
to other countries and this is with CPI which again is by no means real
indicator of India’s present state.
Country
|
Inflation
|
Interest Rate
|
Real Interest Rate
|
USA
|
1.80
|
0.25
|
-1.55
|
EMZ
|
0.30
|
0
|
-0.30
|
Japan
|
0.40
|
0
|
-0.40
|
UK
|
0
|
||
S Korea
|
1.30
|
1.50
|
0.20
|
India
|
4.85(CPI avg 12months)
|
6.75
|
1.90
|
Even if we
consider CPI to be relevant for India, above table shows we are totally at odds
with other major economies. And its not
just about interest rates, after turning their interest rates to zero they have
resorted to massive money printing to increase inflation. Also it should be noted Federal Reserve never
looks at CPI, but core CPI which excludes food and energy as they are volatile
and not part of persistent inflation.
ECB follows HICP but in all policy meets they take a note of core HICP
which again looks into CPI less food and energy. And we are following CPI which has 46 %
weight age of food only. In these
scenarios with such a massive policy ideology difference between India and all
the other central banks and hence the rate differences, can India compete on
global scale? Won’t this be huge
hindrance in make in India, solar mission, smart cities, etc
? Even Pakistan has interest rate of 6 %, 75 bps
less than India.
Chart showing Money Printing by
Global Central banks after 2008 crisis
GDP deflator vs CPI
·
GDP deflator is far better indicator of
inflation than CPI as it covers broad range of goods and services unlike CPI. GDP deflator is pointing to zero inflation in
India almost for a year now.
·
As above chart suggested every major economy in
spite of having negative interest rates is adamant to bring their inflation to
2 %. Implicit target of all these
central bank is just one- higher nominal GDP because- it decreases their total
debt to GDP and increases tax
collection, decreases fiscal deficit and more importantly it keeps ratio of countries
GDP to world GDP elevated. Nominal GDP
for a country today is what landmass captured used to be for a country prior to
World War 2 as it is the single most powerful measure that gives power to a
Nation.
India’s GDP deflator at zero and RBI observed
inflation at 5 % has unprecedented long term implications on many fronts including
foreign affairs and India’s global standing.
Our government is doing everything to be part of UNSC or make INR a part
of SDR but there is no other figure that is more important for this than
India’s GDP to world GDP. At present
this ratio stands at 2.5 % and if this reaches to 5-8% or above it will become
impossible for anyone to stop us from being part of both. But if this kind of yawning gap exists
between GDP deflator and RBI observed inflation it can cut 20- 50 % from our
nominal GDP in a decade in constant dollar term and can have massive
implications on India’s standing on world stage. Inflation that RBI observes for policy
decisions, should he as close to GDP deflator as possible. India’s fastest growing major economy in the
world is a known fact but lesser known fact is india’s Nominal GDP growth have
never been this slow for this long since 1980!!!.
Raghuram is struck in his own
statement of CPI+1.5-2 and hence have lost grip on subjective analysis of the
situation. Tied in his own words and in his decade old ideological war with
western central banks he has made India an experimental ground for his
unrealistic policies. There are many ‘One
Call’ wonders in global financial markets, and he was right in predicting
financial crisis but have been wrong on every call of his on western markets after
that and is again wrong on knowing India’s real problems.
If he would have followed right
kind of inflation indicator and would have taken a cognizance of global economy
and massive excess supply of all commodities and capital, our interest rate
could have been as low as 4 %. This
would have given immense opportunity to India in taking maximum advantage of those
excess supplies in every sector to fulfill the needs of India’s poor as there
is just one place where demand is and that is India. This would have solved all the legacy problems
of India such as PSU banks distress, Discom Distress, Infra-corporate distress
and would have provided domestic funding for all important projects like
housing for all, infrastructure, railways, make in India, digital India and
could have increased tax collection in leaps and bounce -true achche din which our government and
people rightfully deserve and are held hostage by one man Raghuram Rajan.
Suggestions for better RBI
·
MPC is most refreshing news as it eliminates
dictatorial policies. But MPC should be
given dual mandate Inflation and Employment.
Only inflation is power without responsibility. If we can survey inflation then surely
employment and its worth having employment data as not just monetary but
political system may get changed in long runs with its figures.
·
Inflation measure should be as close to GDP
deflator as possible and robotic fixation of inflation should not happen
instead it should be subjective on global and domestic conditions and most
importantly ‘Quality of Deficit’
·
India should strive hard to be part of SDR and
with higher share, as well as to be part of SDR equivalent in AIIB and BRIC
with higher share, and India should make opening of swap lines with foreign
central bank an integral part of foreign policy as there is no bigger control
on inflation than ultimate stop option for currency slides in the form of
swaps.
Hope my observations if pragmatic
can be helpful for nation.
Regards,
Bhavik Joshi
M : 9825506266
Email : corres.bhavik@gmail.com
Bhuj
